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GSE front-end risk sharing worries small lenders

Alternative methods being eyed for the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac to transfer loan-default risk — including expanding the role of private mortgage insurers — are worrying small lenders.

The Federal Housing Finance Agency (FHFA) recently requested input on methods to de-risk the GSE loans on the front end, before the loans are sold and securitized. The most likely alternative would be a greater role for private insurers, who could potentially guarantee up to 50 percent of the unpaid balance of a loan and back the lion's share of the riskier GSE loans.  

Risk storySmall-lender groups mostly favor the status quo, however. Fannie Mae and Freddie Mac have offloaded much of the default risk on 30-year fixed mortgages through back-end deals with a few private investors. Smaller lenders worry about the costs for borrowers with front-end deals, who could potentially pay significantly more in interest-rate payments for deeper private insurance coverage.

For deeper mortgage insurance to be cost effective, the GSEs would have to cut their guarantee fees, which isn't clear at this point. Small trade groups also are highly skeptical that private insurance could pay the claims in the event of a severe downturn and are also worried about further destabilizing the GSEs by cutting their revenue streams.

“Will the [mortgage insurers] be there when the day of reckoning comes?” said Ron Haynie, senior vice president with the Independent Community Bankers of America (ICBA). “The ability and willingness to pay claims is huge. The MIs [mortgage insurers] didn’t do that great last time around.” 

The U.S. Mortgage Insurers (USMI), an industry trade group, however,  says fears that the insurers won't be able to handle deeper coverage are unfounded, given new capital requirements and regulations that have been placed on private insurers. A USMI spokesman also said that private insurers performed well after the crisis, paying "upwards of $50 billion in claims."   

USMI President Lindsey Johnson told Scotsman Guide News she was optimistic that FHFA would move forward with more private insurer involvement.

“They have had 3 ½ years of back-end risk-transfer deals,” Johnson said. “We would like to see them (the GSEs) move faster toward a front-end risk-transfer program.”

The GSEs have mostly handled risk transfers to date by issuing securities, which have been sold to a limited number of investors. These are known as “back-end” deals because the GSEs transfer the risk after purchasing the loans.

This method, however, has been criticized by the Mortgage Bankers Association (MBA) and other industry groups for lacking transparency with respect to the prices the GSEs are paying to warehouse the risk for a period, and because these deals have been open to a limited number of investors. About 25 private companies have purchased roughly two-thirds of the risk.

MBA President David Stevens has advocated an increased role for private insurance, but said the trade group will only support a front-end program that works for all lender sizes. The other method of front-end risk sharing is through lender recourse deals, where the lender retains a portion of the risk on a pool of loans. Fannie and Freddie have used this method in a limited number of transactions, most notably through Fannie’s L Street Securities. The FHFA has acknowledged, however, that the lender-recourse deals aren’t likely to take a big role in future risk transfers.  

"We need a risk-sharing solution that is available to all lenders large and small,” Stevens said. “All lenders must be treated equally and be able to do business with the GSEs.”

Still, it could be a hard sell to get small lender groups on board with other methods to transfer risk.  

“We would be in favor of front-end risk sharing if there is equal access and equal pricing for small lenders,” said Glen Corso, executive director of the Community Mortgage Lenders of America. “We are skeptical that will be the case, however, based on the experience to date with small lenders attempting to have discussions with the GSEs on front-end risk sharing transactions that feature realistic terms and prices.”


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